Toyota Losing No. 1 Makes Prius Priority as Japan Inc. Fades

The 2012 Toyota Camry sedan. The Camry is the best-selling car in the U.S. for 13 of the past 14 years. Source: Toyota Motor Corp. via Bloomberg

Sept. 12 (Bloomberg) -- Two weeks after Japan’s March 11
earthquake knocked out more than 650 of Toyota Motor Corp.’s
suppliers, halting worldwide production, the automaker had to
decide where to focus its resources. It picked the Prius.

“We were rapidly burning through cash,” said Atsushi
Niimi, head of production, in an interview. “We decided we had
to get things going bit by bit to survive through this, so we
prioritized the cars our customers wanted most.”

The carmaker started calling suppliers across the country
to find parts for the Prius and luxury-brand Lexus hybrids. By
March 28, Toyota’s Tsutsumi and Kyushu factories were producing
the models again at 30 to 40 percent of capacity, Niimi said.

By choosing the Prius ahead of the Corolla and Camry sedans
that enabled Toyota to become global No. 1 by 2008, President
Akio Toyoda is staking the future of Japan Inc. on hybrid
technology as the solution to the nation’s worst disaster since
World War II and the company’s initial indifference to customer
complaints that prompted its biggest recall. General Motors Co.
supplanted Toyota as the world’s largest automaker in the first
half of this year, as Japan’s last remaining company in the
world’s top 50 by market value lost customers to GM, Ford Motor
Co. and Hyundai Motor Co. in the U.S. market, which is
recovering from its deepest postwar slump.

“The last several years have been a triple shock for
Toyota,” said Masatoshi Nishimoto, a Tokyo-based automotive
analyst for global consulting company IHS Inc. “It’s now at a
major turning point.”

Lost Share

The fallout from the earthquake and the unprecedented
recalls devastated Toyota sales, which are down 7.8 percent in
2011 through August in the U.S., while GM, Ford, Hyundai and
Chrysler increased shipments by 16, 12, 21 and 21 percent
respectively, according to Autodata Corp. Toyota was outsold in
the U.S. by GM, Ford and the Fiat-Chrysler group in August,
according to data compiled by Bloomberg Industries.

While GM’s share of the U.S. market in the first eight
months increased 1 percentage point to 20 percent and Hyundai’s
rose a half percentage point to 5.2 percent, Toyota lost 2.5
percentage points to 12.7 percent.

The 74-year-old company that Ford Chief Executive Officer
Alan Mullaly once praised for “the finest production system in
the world,” plans to regain market share with at least 11 new
models over the next two years. Analysts including IHS’s
Nishimoto say Toyota’s advances in fuel economy will underscore
its recovery even as rivals narrow the gap in quality and
outsell the Japanese company in emerging markets such as China.

New Prius Cars

Toyoda’s effort to win back market share, which includes
three new versions of the Prius, the world’s top-selling hybrid,
and electric or dual-power versions of other models, is as much
about the company’s strategy to regain its lead as it is about
the Japanese economy’s failure to return to prosperity after two
decades of anemic growth.

The revamped line-up begins this week with the release of
the 2012 model of the Camry, the best-selling car in the U.S.
for 13 of the past 14 years. Toyota has promised another four
releases this year and at least six in 2012.

“Back in the 80s, if someone said Toyota, the first thing
that popped in your mind was Corolla,” said Jim Lentz,
president of Toyota’s U.S. sales, in an interview. “Through the
90s, it was probably Camry. If you ask someone middle of this
decade and beyond, it will be Prius.”

Toyota is focusing on fuel technology to gain sales in
developed markets like North America -- where the company earned
about 70 percent of its operating profit last fiscal year --even
as the quake dented its efforts to catch up in expanding markets
such as China, which overtook the U.S. in 2009 as the world’s
biggest car market and where growth is still dominated by all-gasoline powered vehicles.

China Sales

The production hiatus after the disaster relegated Toyota
to No. 5 in China by sales of passenger vehicles in the first
seven months of this year, trailing Volkswagen AG, GM, Nissan
and Hyundai, according to an August report on the country by
consumer ratings company J. D. Power & Associates.

“Chinese consumers prefer luxury over fuel-efficiency,”
said John Zeng, a Shanghai-based analyst at J.D. Power. “For
the price of a Prius, you can buy an entry-level BMW 5-series.”
With limited government subsidies for hybrids, Toyota’s strength
in China is in mid-size sedans such as the Corolla and Camry,
and large SUVs like the Land Cruiser, where demand will continue
to grow, he said.

Toyota sold 2,261 Prius cars in China in the last four
years, compared with 632,000 Camrys and 809,000 Corollas.

Yen Pain

Toyota’s come-back will be burdened by Toyoda’s commitment
to keeping jobs in Japan as the strongest yen against the dollar
in six decades and looming power shortages make it harder for
the automaker to escape the same fate as Japan’s economy:
sliding competitiveness and stagnant growth. Toyota makes more
vehicles domestically than rivals Honda Motor Co., Nissan Motor
Co. and Suzuki Motor Corp. combined, making it the most-affected
Japanese automaker when the earthquake struck.

Suppliers of 1,260 parts and materials used in Toyota cars
were crippled by the magnitude-9 temblor and tsunami, leading
officials initially to predict a production loss of 2 million
vehicles, or a quarter of the company’s global output last year.

A failure to reverse the decline could add Toyota to the
list of Japanese corporations that once dominated markets from
autos to electronics before losing out to overseas competitors.
Rising competition from companies including Apple Inc., Samsung
Electronics Co. and Hyundai eroded the leads of manufacturers
like Sony Corp. and Toshiba Inc.

Last Survivor

In 1990, when Japan’s asset bubble burst, six of the
world’s 10 biggest companies by market value were Japanese and
Toyota was No. 9, according to a ranking by Businessweek. Toyota
now ranks 35th, the sole Japanese survivor in the top 50.

“The world has changed dramatically since Toyota became
the top carmaker,” said Yuuki Sakurai, Tokyo-based president of
Fukoku Capital Management Inc., which manages 600 billion yen
($7.8 billion) in assets. “Japan became known for producing
high-quality products sold cheaply. With the Koreans and Chinese
catching up, Japan’s position has become ambiguous.”

Toyota’s troubles came to the fore in 2009 and 2010, when
floor-mat and gas-pedal design flaws led to recalls of millions
of vehicles, undermining the company’s reputation for quality.
U.S. sales of the Camry dropped 8.1 percent in 2010 and 7
percent in the first eight months of this year. Sales of
Hyundai’s competing Sonata sedan surged 64 percent last year and
22 percent in the January-August period.

Maximum Fine

Toyota was fined a maximum $16.4 million in April 2010 by
the U.S. National Highway Traffic Safety Administration after
recalling cars in Europe months before doing so in the U.S. In
February, Toyota’s Lentz had told a U.S. Congress committee
investigating the defects that the company “failed to promptly
analyze and respond to information” about the sticking pedals.

Toyota “permanently lost some ground,” said Ed Kim, an
analyst at AutoPacific Inc. in Tustin, California. “Formerly
second-tier players like Hyundai now directly challenge them in
key product segments.”

In June 2009, three months before the recall crisis began,
Toyoda took over as president from Katsuaki Watanabe. By
February 2010, the grandson of Kiichiro Toyoda, the motor
company’s founder, was summoned to appear before the U.S.
Congress committee. Toyoda vowed to fix the problem,
establishing a global committee to oversee quality, from
suppliers through to customers.

Flooded Factories

The complexity of that task was revealed when the
earthquake hit this year, shifting Japan’s northeast coastline
by 3.6 meters and triggering the wave that destroyed more than
100,000 buildings and left more than 15,700 people dead.
Factories around the industrial center of Sendai were flooded or
destroyed, including a Sony plant and hundreds of small
subcontractors for Japan’s manufacturers.

It took Toyota three days to set up the first video link
between headquarters and the company’s newest plant, a factory
near the disaster zone that produced Yaris compact cars.

“The first image we saw was of everyone in helmets in
darkness, standing very still,” production chief Niimi said in
an interview in Toyota City, about 600 kilometers (400 miles)
from the quake’s epicenter.

Toyota’s parts system relies on thousands of companies --
suppliers of suppliers of suppliers. So when the quake struck,
the company didn’t know how badly it was affected. Employees
spent days calling suppliers and searching the Internet to try
to find out where all its part-makers were, marking them with
push pins on a map, said Niimi, 64.

Head Spinning

“My head was spinning,” he said. By contrast, the 1995
Kobe earthquake, which killed more than 6,000 people, damaged 14
Toyota suppliers producing 30 parts.

The lack of components cut Toyota’s output by 23 percent in
the first half, to 3.38 million units, allowing it to be
overtaken by both GM and Volkswagen AG in global sales.

Toyota’s stock fell 2.1 percent to 2,625 yen as of the 3
p.m. close of trading in Tokyo, extending its decline to 28
percent since the day before the earthquake and 68 percent from
a peak in February 2007. Goldman Sachs Group Inc. lowered its
12-month target price to 3,600 yen from 4,000 yen on Aug. 18,
citing higher incentive spending in the U.S. and possible excess
inventories next year. Of 23 analysts surveyed by Bloomberg, 10
recommend Toyota as a “buy,” while 13 rate it a “hold.”

Fitch Ratings downgraded Toyota’s long-term foreign and
local currency issuer default ratings and senior unsecured debt
rating today to A from A+, with a stable outlook, the ratings
company said in a statement.

Toyota’s slump recalls the decline in competitive edge of
other Japanese brands that once dominated. In the 1980s, Sony’s
Walkman music player and Trinitron TV were leaders, capturing
the imagination of a young Steve Jobs, co-founder of Apple, who
was given an early Walkman by Sony co-founder Akio Morita.

Jobs’s Walkman

“Steve was fascinated by it,” said former Apple CEO John
Sculley in an interview in December. “The first thing he did
with his was take it apart, and he looked at every single part.
He didn’t want to be Microsoft. He wanted to be Sony.”

In the mid 1990s, Sony’s PlayStation games console helped
it sit atop the video-games industry.

Then, as Japan’s economy stagnated over two “lost
decades” Sony’s reputation in consumer innovation waned. Apple
is now the biggest maker of smartphones and has 61 percent of
the tablet computer market. Sony begins selling its tablet this
month, more than a year after the iPad went on sale. Last year,
South Korea’s Samsung Electronics made twice as many TVs as
Sony.

Others suffered a similar fate. In the 1990s Toshiba owned
almost 100 percent of the market for the flash memory chips it
invented. Sharp Corp. pioneered liquid-crystal displays. Samsung
overtook both by outspending them each year on more advanced
manufacturing plants.

‘Long Time Ago’

“The iPod/iPad set of products is something that a long
time ago, one might have expected a Japanese firm to come up
with,” said Robert Feldman, head of Japan economic research at
Morgan Stanley MUFG Securities Co. in Tokyo, who used to work at
the Federal Reserve Bank of New York and the International
Monetary Fund. “Some of Japan’s competitors, particularly the
Koreans, are becoming very good at many of the things Japan used
to be best at. Japan’s competitiveness has worsened.”

Sony in May posted its widest annual net loss in 16 years,
the first time the company has had three straight full-year
losses since it listed in 1958. While Apple’s profit more than
doubled in the three months ended June, Toyota’s fell 99
percent.

In the weeks following the earthquake on March 11 -- known
as “san ten ichi ichi” or 3/11 in Japanese -- Toyota worked to
rebuild its manufacturing network. While its darkened plant near
Sendai, in Miyagi prefecture, suffered little damage, many
suppliers had plants destroyed.

Navigation Lost

Among the biggest challenges was semiconductor maker
Renesas Electronics Corp., which makes chips that run dashboard
meters, navigation and audio systems. Toyota and other customers
sent 2,500 workers to help repair Renesas’s Naka building, water
and electricity systems. It took 2 1/2 months before the plant
resumed operation.

Japan’s national effort to recover from the quake helped
bring factories back on line quicker than expected. Toyota now
estimates a shortfall of only 150,000 units this fiscal year.

Even without the damage from the quake, Japanese companies
have had to cope with a domestic economy that has grown at an
average 1.2 percent annually in the past 21 years.

More than two decades of government spending to revive
growth have saddled the country with the world’s highest level
of public debt. Japan has had deflation for more than a decade,
and has the world’s oldest society with a median age of 44,
according to the United Nations. Downward pressure on wages has
sapped consumer spending on cars, televisions and appliances.

Growth Downgraded

Japan’s economy contracted at an annualized 2.1 percent
rate in the three months ended June, its third consecutive
quarter of decline. The government downgraded its growth
forecast to 0.5 percent in the year started April, from 1.5
percent, to reflect the quake’s effect.

The stronger yen has sapped exporters’ profits. Following
the 2008 global financial crisis, investors treated the Japanese
currency as a haven, sending it to a post-World War II high of
75.95 to the dollar on Aug. 19, from almost 95 in May last year.

A 15-yen change in the rate over the past year has “blown
off” 300,000 yen, or $3,900, in profit on a $20,000 car,
Takahiko Ijichi, Toyota’s senior managing officer, said on Aug.
2. That cut Toyota’s fiscal first-quarter operating profit by 50
billion yen, he said.

Japan’s former finance minister, Yoshihiko Noda unveiled a
$100 billion effort on Aug. 24 to help companies cope with the
yen’s rise, releasing foreign-exchange reserves to the state-run
Japan Bank for International Cooperation to aid exporters, hours
after Moody’s Investors Service lowered the nation’s debt rating
for the first time since 2002. Noda was elected to succeed Naoto
Kan as prime minister on Aug. 30.

Idled Reactors

Worse still for Japan’s manufacturers may be the long-term
effect of the earthquake on power supplies. When the sea surge
knocked out cooling systems at Tokyo Electric Power Co.’s plant
in northern Japan, three reactors went into meltdown, plunging
the nation into the world’s worst nuclear crisis since the 1986
accident in Chernobyl, Ukraine.

Forty-three of Japan’s 54 atomic reactors were offline as
of Sept. 5, according to data compiled by Bloomberg News. Before
the Fukushima failure, nuclear energy provided 30 percent of
Japan’s electricity, a number Kan had promised to reduce in a
shift to renewable energy.

Industries in parts of Japan were ordered to cut
consumption by 15 percent from July 1 to help mitigate
shortages. Toyota, Honda and Nissan began closing plants on
Thursdays and Fridays and operating during weekends.

LCD-maker Sharp and Mitsui Mining & Smelting Co., Japan’s
biggest zinc smelter, said they plan to move production abroad
because of concern that nuclear plants will remain closed,
extending power shortages.

‘Endless Obstacles’

“Manufacturers here have faced endless obstacles such as
foreign exchange rates, corporate tax and environmental and
labor regulations,” Sharp Chairman Katsuhiko Machida said at a
briefing in Osaka on July 15. “This issue over power supply
could be the end of manufacturing in Japan.”

Japan’s effective corporate tax rate is 41 percent,
compared with 25 percent in China and 24 percent in South Korea,
according to KPMG LLP’s 114-nation survey in 2010.

“We’ve seen pressure for more and more Japanese
manufacturing to move offshore,” said Feldman at Morgan
Stanley. “Then we have the earthquake. Then we have the power
problem. And now we have the yen at 76. Japanese companies have
a lot of trouble competing at that level.”

While a manufacturing exodus might benefit companies moving
production to countries with higher growth, it would further
undermine Japan’s recovery, he said. “The companies will just
shift the jobs somewhere else. This is extremely serious.”

Japanese Jobs

Even Toyoda’s stated aim of preserving Japanese jobs has
come under strain. Toyoda has pledged to make small hybrid cars
in quake-hit Iwate prefecture and spend 2 billion yen on a new
engine factory in Miyagi.

“How much longer should we insist on producing in Japan?”
said Chief Financial Officer Satoshi Ozawa, seated next to
Toyoda at a press conference in May. “Our efforts may have
exceeded the limits of what is possible in dealing with the
yen’s impact.”

Even Toyota’s overseas plants like the Camry factory in
Georgetown, Kentucky, still rely for some parts, particularly
electronics, on Toyota’s vast supplier network in Japan. That
plant is crucial because Toyota’s recovery in its biggest market
will be measured by a rebound in market share, which fell to 15
percent last year from 17 percent in 2009, production manager
Niimi said.

Toyoda was at the Kentucky factory on Aug. 23 to drive the
first of the new Camrys off the production line in an event
relayed to a ceremony at Paramount Studio’s “New York City”
backlot in Hollywood, with 200 actors, dancers and musicians.

Japanese Crown

“In the two short years I have been president of Toyota,
my focus has never wavered from one goal: product, product and
product,” Toyoda, 55, told workers. “This vehicle has become a
symbol of Toyota’s success over the years. This is an
opportunity to show the world again what Toyota is all about.”

The Camry -- an Anglicized spelling of “kanmuri,” or
“crown” in Japanese -- is the first of 20 new and refreshed
Toyota, Lexus and Scion models arriving in the U.S. between now
and 2013.

“The cadence comes faster than I’ve seen in 30 years with
Toyota,” Bob Carter, group vice president of U.S. sales, said
in an interview. Under Toyoda “there is a renewed focus on
products themselves that we haven’t seen in years.”

Toyota plans to add the hybrid Prius v wagon, revamped
Yaris subcompact, Scion iQ minicar and modified Tacoma pickup
this year. Releases in 2012 include a plug-in version of the
Prius and compact Prius c hybrid, new Lexus GS sport sedan,
battery-powered RAV4 sport-utility vehicle and electric version
of the iQ, as well as the rear-wheel drive Scion FR-S sport
coupe, Carter said.

Running Overtime

As Toyota’s plants run overtime to build the new models,
Toyota may reclaim some ground, with its global market share
rebounding to 11 percent in 2012, from 9.7 percent this year,
and its U.S. share rising to 14 percent, from 13 percent,
according to IHS’s Automotive division in Englewood, Colorado.
Still, the company will struggle to recapture the lead it
enjoyed before the financial crisis, said Tokyo-based IHS
analyst Nishimoto.

The automaker told suppliers that the new models are
expected to cause global production to rebound in 2012 to 8.9
million units, an all-time high, from 8.04 million vehicles
forecast for this year, according to Nobuaki Katoh, president of
Denso Corp., Toyota’s biggest supplier.

In parallel, Japan’s economy will get a boost next fiscal
year from reconstruction, with the Bank of Japan forecasting GDP
to rise 2.9 percent compared with 0.4 percent this year.

Falling Birthrate

That won’t be sustained because the falling birthrate means
the economy’s losing a key driver of growth, according to
Yoshimasa Maruyama, a senior economist at Itochu Corp. in Tokyo.

“The country can no longer expect the kind of high-speed
growth it once had,” said Maruyama. “We can’t change that.”

The Bank of Japan estimates growth in the long run will be
around 0.5 percent.

Japan still has examples of leading companies, including
Canon Inc., the world’s largest camera maker; and Fanuc Corp.,
which makes controls that run more than half the world’s
computerized tools.

To rejoin them, Toyota may need to reduce its dependence on
production in Japan and sales in the U.S., said Fukoku Capital’s
Sakurai.

“Toyota’s future success will depend on just how global a
company it can be,” he said. “It needs to diversify its
operations and risks more.”

Etios in India

Toyota has said it plans to get half of its global sales
from emerging markets by 2015 with models such as the Etios
sedan, its cheapest car, which began selling in India in
December. The company aims to introduce a similar vehicle in
China, Brazil and Thailand, said Yoshinori Noritake, chief
engineer of the Etios.

“We need to introduce entry-level vehicles there as soon
as possible,” he said. Toyota entered the Chinese market after
rivals, setting up its first assembly plant in 2000, 16 years
after Volkswagen.

Still, Toyota’s edge in its biggest market in North America
is the Prius and hybrids that allow drivers to cut fuel
consumption, said Jesse Toprak at TrueCar.com, an auto pricing
and data service in Santa Monica, California. Regular gasoline
retailed in the U.S. for an average $3.655 on Sept. 7, up 97.5
cents from a year earlier, according to the American Automobile
Association.

Backbone Engine

“Prius is going to be the backbone of our powertrain
philosophy going forward,” said Toyota’s U.S. sales chief
Lentz. “The vast majority of vehicle sales we’re going to have
are going to be hybrids.”

The new $25,900 Camry Hybrid’s 41 miles per gallon average
tops the Hyundai Sonata Hybrid’s 37 mpg and Ford Fusion Hybrid’s
39 mpg, according to U.S. Environmental Protection Agency data.

“Having the biggest number of fuel-efficient vehicles does
differentiate Toyota,” said Toprak. “The Prius line expansion
should generate sales, particularly if fuel prices rise again.”

Competition is tougher in quality and technology than it
was in the first quarter of 2007, when Toyota ended GM’s seven-decade reign as the world’s biggest automaker. Hyundai’s new
Equus came fourth in this year’s U.S. new-car quality survey by
Westlake Village, California-based J.D. Power, which has been
conducting customer research since 1968. Only two of Toyota’s
Luxury brand Lexus models and Porsche Automobil Holding SE’s 911
beat the South Korean car.

“For Toyota to get back to where it was in 2007, you’d
have to beat Hyundai back to where they had been, beat Nissan
and Ford back to where they had been,” AutoPacific’s Kim said.
“I just don’t see that happening.”